Tesla's $2,000 price cut doesn't mean it has a demand problem

Tesla cut prices on its vehicles by $2,000, setting off worries that it has a demand problem.

But based on how few vehicles it has in inventory and how many Model 3s it sold in 2018, demand concerns are overblown.

Tesla shares have been declining this week — but Tesla's stock has always been volatile.

Tesla announced fourth-quarter and full-year vehicle sales on Wednesday. They were a bit lighter than some analysts' projections, but the company still delivered close to 250,000 cars in 2018 — a milestone, and a miracle of sorts, given how much trouble the new Model 3 sedan caused as it made it way through what CEO Elon Musk termed "production hell."

The stock swooned, but that might have been due more to worries about demand for Tesla vehicles going forward, as the company also cut prices by $2,000 to make up for an expiring federal tax credit of $7,500 per car (it was chopped in half after Tesla sold 200,000 qualifying vehicles).

As I pointed out on Wednesday, a $2,000 Tesla price cut is roughly 50% below what the rest of the auto industry is offering, on average, to sell cars in the US right now; the GMs and Fords just call it an "incentive."

Tesla's cars are arguably a tad overpriced anyway, so trimming the sticker could actually be the right thing for the company to do, especially for less affluent consumers. It bears repeating: the tax credit is worthless if you don't actually owe the IRS anything for 2018. And the folks most likely to owe are, you know, rich.

Analysts have been fretting over Tesla demand for years. This has been due largely to the lack of a meaningful electric-car market; globally, EVs make up just 1% of total sales.

Still, Tesla was able to sell another 100,000 of its luxury Model S and Model X vehicles in 2018, repeating 2017's result. The other approximately 150,000 cars it sold were Model 3s — a car that didn't really exist in 2017 and that found an impressive number of buyers in 2018. By contrast, Chevy will likely sell 16-17,000 Bolt EVs in 2018.

The gaps between those vehicles' sales mean that Tesla has essentially created a new market for a near-luxury EV priced between $40,000 and $80,000 at the top end (and Chevy has shown that there is a consistent, if modest, market for a lower-priced EV.) That's a good thing in the short term because Tesla can gobble up all the sales. Longer term, the question is, "How big is that market?"

Tesla is basically selling every car it can make

Tesla's factory. Benjamin Zhang/Business Insider

With something like 400,000 preorders for the Model 3, Tesla could argue that it's satisfied about half the initial demand for the car. A lot of buyers continued to wait for the $35,000 "base" Model 3, but at the moment it's probably good that Tesla isn't selling it because it would post much lower profit margin if it posts one at all. And Tesla needs profits to stay afloat.

As for overall Tesla demand in 2019, it looks to be holding up, if you use the metric of "days supply." Tesla has a few weeks of inventory, a rather low level of days supply compared to the rest of the car business. Ford, for example, has more than two months worth of F-150 pickups sitting around at the moment — something on the order of 200,000 vehicles. It has to maintain that much inventory to satisfy daily demand for 2,500 new trucks.

Plus, Tesla seems to be "conquesting" buyers from other luxury marques, such as BMW, Audi, and Mercedes. Right now, I'd call it curiosity conquesting. Only time will tell if longtime BMW 3-Series owners stick with their Model 3s.

Those are the nuts and bolts of Tesla's auto business as we commence 2019. So what about the stock? Why is it sliding?

Because it's a volatile stock as it has always been! My advice is to treat it as a gauge of how much unjustified optimism there is about Tesla becoming one of the world's biggest carmakers by sales. Tesla mega-bulls see Musk and his company delivering many millions of vehicles annually ... someday. Hence the $500-ish target prices from some boosters. Anything that threatens that growth narrative or that collides with the harsh realities of actually building those millions of vehicles will ding the stock.

How will we know if Tesla has a true demand problem? Much bigger price cuts, for starters, and if when the company unveils its Model Y compact SUV later in 2019, as anticipated, it doesn't rack up a lot of pre-orders. Until then, demand worries are overblown.